Non-Qualified Plan

What it is:

A non-qualified plan is a retirement plan to which the IRS does not grant specific tax benefits.

How it works (Example):

A non-qualified retirement plan is essentially whatever a qualified plan is not. In other words, if the plan does not meet the myriad of exact requirements the Internal Revenue Code section 401(a) and the Employee Retirement Income Security Act of 1974 (ERISA), the retirement plan is non-qualified.

But in general, the IRS deems defined-benefit plans and defined-contribution plans as qualified retirement plans (though hybrid plans, which combine elements of the two, are also acceptable in some cases). Defined-benefit plans are usually traditional pension plans; defined-contribution plans are often 401(k) plans, 403(b) plans, money-purchase pension plans, or profit-sharing plans. Non-qualified plans might involve trusts, life insurance policies, or deferred compensation plans, and the assets in these plans might be mixed with the assets of the employer (qualified plans don’t allow that).

This means that if a plan is non-qualified, employers generally cannot deduct contributions they make to the plans on behalf of their participants, and plan participants cannot exclude their contributions from their taxable income. Additionally, the earnings on the retirement plan funds are usually taxable.

Why it Matters:

Knowing whether a retirement plan is a qualified retirement plan is important, because having one entitles the participant to certain tax advantages that are not available to people saving for their retirement by other means. Given that tax deductions, tax credits, and tax deferrals can create significant differences in retirement income when compounded over several years or even decades, finding a qualified retirement plan is one of the most important things an investor can do to ensure adequate income after he or she stops working. Of course, qualified retirement plans do have their limitations, namely that the funds are often unavailable to the investor until he or she retires and sometimes are limited in terms of allowed investments. In those cases, a non-qualified plan might fit the bill.

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